A simple, but elegant new investment strategy from Ord Minnett that Head of Fixed Income research Brad Dunn says is an ASX-traded alternative to TDs.

Essentially, the Ords approach is to invest in three XTB floaters with staggered interest payment dates. This gives investors & retirees monthly income payments, without having to worry about rolling TDs and with T+2 access to their capital.

TD Alternative: Floating Rate XTBs

The approach limits exposure to risks inherent in other alternatives:

Capital risk – equities & hybrids,

Interest rate risk – long-dated fixed-coupon bonds, and

Liquidity risk – long-term TDs.

At-call cash & TDs currently yield from, circa 1.8% to the high-twos, with some short-term special rates hitting 3%. Senior floating-rate bank bonds underpinning XTB floaters can deliver returns in the low-threes, on an after XTB-fee basis, with low long-term average volatility (0.6% p.a.).

The following tables are taken from the Ord Minnett research that will form part of a broader piece in Ord’s next quarterly research publication.

The first table below compares 5 aspects of floating rate XTBs – a security traded on ASX, with TDs – a bank account that attracts the government guarantee for balances up to $250,000.

XTB (Floating Rate)

Term Deposit

Legal Definition

Direct, unconditional, floating rate, unsecured deposit liabilities, ranking equally with all other unprotected deposit obligations of the Issuer and rank at least equally with all other unsecured and unsubordinated obligations of the Issuer.

Fixed rate, fixed term deposit liabilities offered by accredited deposit-taking institutions, which are protected by a government guarantee up to the value of $250,000 per account per institution.

Coupon Structure

BBSR90 + Margin (reset quarterly)

Fixed at time of establishment

Coupon Payment

Quarterly

Conclusion of Term, or

Quarterly or Monthly (-0.1% to -0.2% off advertised rates)

Liquidity

T + 2 (Buy-Sell Spread ~0.1%)

Limited (Substantial break fees and/or waiting periods apply)

Volatility

0.6% per annum (long-term average of senior floating rate index)

Nil (if held to term)

Note: BBSR90 – is the 90 day bank bill swap rate, which is the variable benchmark against which coupons are set.

The volumes available for XTB floaters across the 10bps bid–offer spread on ASX noted above are generally about $2m on both bid and offer. The underlying floating rate bonds are among the more liquid corporate bond issues and so if larger trade size is needed, brokers and advisers can call either the XTB manager, Australian Corporate Bond Company Ltd, or the floating-rate XTB Market Maker, Challis Investment Partners, to discuss larger block trades and best execution methods.

In its analysis, Ords used the following three XTBs:

CODE

ISSUER

COUPON

ALLOCATION

YTMF03

Bank of Queensland

BBSR + 1.00%

$50,000

YTMF05

National Australia Bank

BBSR + 0.85%

$50,000

YTMF06

Suncorp-Metway

BBSR + 1.10%

$50,000

Based on a $150,000 portfolio split evenly across the XTBs, Ords generated the following monthly income, assuming a 12-month holding approach, with the income subject to movements in the bank bill swap rate (which delivers the floating rate nature of both bond and XTBs).

Month

Cashflow

April

$398.79

May

$370.91

June

$382.96

July

$398.79

August

$370.91

September

$382.96

October

$398.79

November

$370.91

December

$382.96

January 2017

$398.79

February

$370.91

March

$382.96

TOTAL

$4,610.63

Running Yield

3.07%

Source: IRESS, Ord Minnett estimates

The main risks to any holding of floating rate XTBs, or the underlying bonds are firstly – that interest rates fall, which will impact coupons and yield, but not the capital price of the XTBs, and secondly – there is an increase in credit spreads that would result in lower capital prices for the XTBs.

Note the banks in the ASX top 50 have historically had relatively low volatility in credit spreads to government bonds. As floating rate senior bonds are far less sensitive to interest rates than fixed coupon bonds, the price volatility that does exist (0.6% per annum as a long-term average of the relevant Bloomberg senior floating rate index), can be largely attributed to credit spread changes.